How To Protect Yourself In A Divorce Using A Domestic Asset Protection Trust

There is a word in a relationship that sparks more fear than even the dreaded words, “We need to talk.” That word is prenup. Successful and confident grown men and women shutter at having to breach this subject with their soon-to-be spouse. It’s a painful conversation that all want to avoid – and many do after they decide it would be too uncomfortable and too awkward. The result? They leave their assets unprotected and subject to division in a divorce. But even those who had the prenup conversation and subsequently got divorced will tell you, a prenup is not bullet-proof and can – and usually are – contested. Even if the prenup is ultimately deemed legitimate, it can still cost you thousands (if not hundreds of thousands) in legal fees proving this.

Is there a better way to retain your separate assets in a marriage and after a divorce that doesn’t require the prenup conversation? For some people in certain situations, the answer may be yes.

Enter the Domestic Asset Protection Trust or DAPT. A domestic asset protection trust is an advanced asset protection strategy that many wealthy individuals and families are using to shield their assets from creditors, and it turns out, it can also be a good vehicle to protect assets in a divorce.

Here’s how a domestic asset protection trust works. Unlike a traditional revocable living trust that many people have, a DAPT is an irrevocable trust. Why is this important? When you get in a bind, a creditor can come after any assets that you have control over. A revocable living trust, by design, is one in which you have control over the assets. You can terminate the trust, withdraw funds, etc. A creditor slips into your shoes and would have the same ability to withdraw funds to pay the claim. In a traditional irrevocable trust, you relinquish any right to the assets and have no control over them. If you don’t have control and can’t withdraw the assets, your creditors can’t either. But, and this is a big but for most people, who wants to give up control of their assets? What if there was a way for you to put assets into an irrevocable trust but still be a beneficiary of the assets? And what if your creditors still couldn’t access the assets? This is where the domestic asset protection trust comes in. It allows the trust creator to be a discretionary beneficiary, and yet the trust assets are still protected from the creator’s/beneficiary’s creditors.

This is possible because a handful of states (currently 15) have specifically allowed this structure (even if you don’t live in one of the states you can still take advantage of their laws). One of the better states to consider is Nevada because they allow no “exception creditors.” In the other states, they allow some certain creditors to attach your assets – the states block most creditors but allow a few exceptions to gain access to your assets. For example, a state may block all creditors but not spouses. Having your trust and assets in this state would shield you from attachment in a lawsuit, but not in a divorce. This is why the Nevada Asset Protection Trust (NAPT) has grown in popularity for protecting assets in a divorce.

However, not all assets are appropriate for a DAPT/NAPT – especially if you do not live in the state in which you have the trust. For example, real assets such as a house in California may not be a good choice since the asset itself is in California and not Nevada. Better assets to transfer into a Domestic Asset Protection Trust or Nevada Asset Protection Trust would be cash, stocks, bonds, mutual funds and other non-real assets that can be held in Nevada.

If you’re willing to have the prenup conversation, you can couple a Nevada Asset Protection Trust with a prenup to provide greater protection of the assets you bring into the marriage as well as the assets and income you make while married. The combination of these two can provide excellent protection.

To better explore the use of Domestic Asset Protection Trusts and Nevada Asset Protection Trusts, I spoke with senior trust officer of Nevada-based ProvidentTrust, Neil Schoenblum. This is an abbreviated version of a much longer discussion we had.

ROBERT PAGLIARINI: Let’s talk about domestic asset protection trusts (DAPTs) and how you can use them to protect yourself in a divorce. To begin with, can you describe what a domestic asset protection trust is?

NEIL SCHOENBLUM: A domestic asset protection trust (DAPT) allows the settlor (the trust creator) to be a discretionary beneficiary of the trust, while also at the same time assuring protection of trust assets from claims of the settlor’s creditors.

ROBERT: How are DAPTs different from a living trust, which a lot of listeners may already have?

NEIL: The main difference is that a living trust is revocable. That means you can change it, you can get rid of it, you can modify it however you want. Importantly, creditors, including a divorcing spouse, can reach the assets held in this type of trust.

ROBERT: So when it comes to safeguarding assets, a living trust doesn’t offer much protection?

NEIL: Right. On the other hand, a NAPT can’t be reached by creditors, including a divorcing spouse. What we’re talking about here is the trust creator having the best of both worlds-- actually retaining access as a discretionary beneficiary and also protecting his or her assets. While the creator of the trust is a discretionary and not a mandatory beneficiary, he or she can retain the power to replace the trustee. As for the trust itself, it has the additional virtue in community property states like California of segregating the assets out and keeping them separate during the marriage thereby avoiding the risk that such property, or the income and appreciation thereon, might otherwise be commingled and be deemed community property in part or whole.

ROBERT: So how do DAPTs work in a marriage to protect assets? Do they need to be set up before the marriage? Can they be set up during the marriage?

NEIL: We’ve actually seen DAPTs become part of the premarital planning. Clients are using these DAPTs either in addition to the prenup or in lieu of the prenup. DAPT planning should certainly not be done right before a divorce. And again, I would even counsel that it shouldn’t be done during a marriage. That might be regarded as a fraudulent transfer, a breach of a fiduciary duty owed by one spouse to the other, or, in the case of a community property state like California, part of the property may already be considered to belong 50% to the spouse. By acting before marriage, you’re basically stashing away a “nest egg,” and setting aside a certain amount of your assets to be protected in the event the relationship unexpectedly terminates, notwithstanding your hope and expectation to the contrary.

ROBERT: Right, so if you’re going to get married, instead of a prenup (or maybe in addition to a prenup) you could set up this trust and transfer assets into it. How does that work with the seasoning period? For example, if I’m getting married in 6 months, I create this trust and put assets in it. I then get married, and a year into the marriage we decide to get divorced. Because the seasoning period hasn’t fully been expired to the two years set forth under Nevada law, does my soon-to-be ex-spouse have some sort of claim to these assets?

NEIL: We have to look at what state we’re dealing with. Are there community property rights?

ROBERT: Let’s look at California.

NEIL: Nevada’s statute is very clear regarding the two year period. Before then, yes, in theory, the assets could be vulnerable to some sort of claim from your soon-to-be ex-spouse. The claimant, however, even then, still has to prove that there was a fraudulent transfer or a violation of a contract or court order, and has to do so with clear and convincing proof--a more demanding standard of proof than the ordinary one of a preponderance of the evidence. In the case of a NAPT created before the marriage, there would be no contract obligation or court order. Thus, the only basis for undoing it would be clear and convincing evidence of a fraudulent transfer. The argument would have to be made that the transfer into trust in anticipation of marriage was done with intent to defraud, hinder, or delay anticipated divorce claims within two years. However, this would be difficult to establish, since why would someone who was getting married do so with the intent to divorce or expect that divorce would be sought by the other spouse within two years of the time of transfer? Again, once two years had transpired from the time of the transfer there would no longer be a possibility of challenge. So let’s say the NAPT is created right before the couple gets engaged a year before the wedding date. If they remain married for one year, the assets in the trust cannot be reached if they divorce thereafter. Further, even if they divorce within a year of their wedding, the other spouse will still have a hard time overcoming the clear and convincing standard of proof I just referenced.

If you want more information, listen or read my full interview with Neil Schoenblum on Domestic Asset Protection Trusts.

Connect with me on Twitter @rpagliarini, my financial planning blog, or email me. This discussion is not intended as financial, legal or tax advice, and cannot be relied upon for any purpose without the services of a qualified professional.